Rolfs v. Commissioner

In the

United States Court of Appeals

For the Seventh Circuit

No. 11-2078

T HEODORE R. R OLFS, et al.,

Petitioners-Appellants,

v.

C OMMISSIONER OF INTERNAL R EVENUE,

Respondent-Appellee.

Appeal from the United States Tax Court.

No. 9377-04—Joseph H. Gale, Judge.

A RGUED O CTOBER 25, 2011—D ECIDED F EBRUARY 8, 2012

Before E ASTERBROOK, Chief Judge, H AMILTON, Circuit

Judge, and M YERSCOUGH, District Judge.Œ

H AMILTON, Circuit Judge. Taxpayers Theodore R. Rolfs

and his wife Julia Gallagher (collectively, the Rolfs)

purchased a three-acre lakefront property in the Village

of Chenequa, Wisconsin. Not satisfied with the house

Œ

The Honorable Sue E. Myerscough of the Central District of

Illinois, sitting by designation.

2 No. 11-2078

that stood on the property, they decided to demolish it

and build another. To accomplish the demolition, the

Rolfs donated the house to the local fire department to

be burned down in a firefighter training exercise. The

Rolfs claimed a $76,000 charitable deduction on their

1998 tax return for the value of their donated and de-

stroyed house. The IRS disallowed the deduction, and

that decision was upheld by the United States Tax Court.

Rolfs v. Comm’r of Internal Revenue, 135 T.C. 471 (2010).

The Rolfs appeal. To support the deduction, the Rolfs

needed to show a value for their donation that exceeded

the substantial benefit they received in return. The Tax

Court found that they had not done so. We agree and

therefore affirm.

Charitable deductions for burning down a house in a

training exercise are unusual but not unprecedented. By

valuing their gifts as if the houses were given away

intact and without conditions, taxpayers like the Rolfs

have claimed substantial deductions from their taxable

income. But this is not a complete or correct way to

value such a gift. When a gift is made with conditions,

the conditions must be taken into account in determining

the fair market value of the donated property. As we

explain below, proper consideration of the economic

effect of the condition that the house be destroyed

reduces the fair market value of the gift so much that

no net value is ever likely to be available for a deduction,

and certainly not here.

What is the fair market value of a house, severed from

the land, and donated on the condition that it soon be

No. 11-2078 3

burned down? There is no evidence of a functional mar-

ket of willing sellers and buyers of houses to burn.

Any valuation must rely on analogy. The Rolfs relied

primarily on an appraiser’s before-and-after approach,

valuing their entire property both before and after de-

struction of the house. The difference showed the value

of the house as a house available for unlimited use. The

IRS, on the other hand, presented experts who attempted

to value the house in light of the condition that it be

burned. The closest analogies were the house’s value

for salvage or removal from the site intact.

The Tax Court first found that the Rolfs received a

substantial benefit from their donation: demolition

services valued by experts and the court at approximately

$10,000. The court then found that the Rolfs’ before-and-

after valuation method failed to account for the condi-

tion placed on the gift requiring that the house be de-

stroyed. The court also found that any valuation that

did account for the destruction requirement would cer-

tainly be less than the value of the returned benefit.

We find no error in the court’s factual or legal analysis.

The IRS analogies provide reasonable methods for ap-

proximating the fair market value of the gift here. The

before-and-after method does not.

I. Legal Background Concerning Charitable Donations Under

Section 170(a)

The legal principles governing our decision are

well established, and the parties focus their dispute on

competing valuation methodologies. We briefly review

4 No. 11-2078

the relevant law, addressing some factual prerequisites

along the way.

The requirements for a charitable deduction are gov-

erned by statute. Taxpayers may deduct from their

return the verifiable amount of charitable contributions

made to qualified organizations. 26 U.S.C. § 170(a)(1).

Everyone agrees that the Village of Chenequa

and its volunteer fire department are valid recipients

of charitable contributions as defined under section

170(c). To qualify for deduction, contributions must also

be unrequited — that is, made with “no expectation of a

financial return commensurate with the amount of the

gift.” Hernandez v. Comm’r of Internal Revenue, 490 U.S. 680,

690 (1989). The IRS and the courts look to the objective

features of the transaction, not the subjective motives of

the donor, to determine whether a gift was intended

or whether a commensurate return could be expected

as part of a quid pro quo exchange. Id. at 690-91.

The Treasury regulations implement the details of

section 170, instructing taxpayers how to prove a deduc-

tion to the IRS and how to value donated property using

its fair market value. Under section 1.170A-1(c) of the

regulations, fair market value is to be determined as of

the time of the contribution and under the hypothetical

willing buyer/willing seller rule, wherein both parties

to the imagined transaction are assumed to be aware of

relevant facts and free from external compulsion to buy

or sell. 26 C.F.R. § 1.170A-1(c). As with the question of

the purpose of the claimed gift, fair market value

requires an objective, economic inquiry and is a question

of fact.

No. 11-2078 5

We can assume, as the record suggests, that the Rolfs

were subjectively motivated at least in part by the hope

of deducting the value of the demolished house on

their tax return. Applying the objective test, however,

we treat their donation the same as we would if it were

motivated entirely by the desire to further the training

of local firefighters. Objectively, the purpose of the trans-

action was to make a charitable contribution to the

fire department for a specific use.1 The Rolfs docu-

mented their donation and substantiated the basis of

their valuation for the IRS as required by the regula-

tions. The Tax Court did not hold that the transaction

was categorically invalid under section 170(a), and we

agree that nothing in the structure or technical execu-

tion of the Rolfs’ donation precluded its potential

validity as a qualifying charitable contribution under

section 170(a). The Tax Court found instead that when

the transaction was properly evaluated, the Rolfs

(a) received a substantial benefit in exchange for the

1

The fire chief asked the Rolfs for $1,000 in cash for the fire

department to help defray costs of the training exercise. The

Tax Court did not make an explicit finding as to whether the

$1,000 cash donation was an essential condition for the fire

department’s acceptance of the donated house. If it was an

essential condition, then in light of the Tax Court’s finding

that the Rolfs received benefits of up to $10,000 in demoli-

tion services in return, one might easily view the entire transac-

tion objectively as merely a contract for discounted demoli-

tion services and not as a charitable donation at all. The IRS

did not argue this theory, so we express no opinion on

its possible merit.

6 No. 11-2078

donated property and (b) did not show that the value

of the donated property exceeded the value of the

benefit they received. We also agree with these find-

ings. There was no net deductible value in this donation

in light of the return benefit to the Rolfs.

A charitable contribution is a “transfer of money or

property without adequate consideration.” United States

v. American Bar Endowment, 477 U.S. 105, 118 (1986). A

charitable deduction is not automatically disallowed if

the donor received any consideration in return. Instead,

as the Supreme Court observed in American Bar Endow-

ment, some donations may have a dual purpose, as when

a donor overpays for admission to a fund-raising dinner,

but does in fact expect to enjoy the proverbial rubber

chicken dinner and accompanying entertainment. Where

“the size of the payment is clearly out of proportion to

the benefit received,” taxpayers can deduct the excess,

provided that they objectively intended it as a gift. Id.

at 116-18 (“The taxpayer, therefore, must at a minimum

demonstrate that he purposely contributed money or

property in excess of the value of any benefit he received

in return.”). In practice then, the fair market value of

any substantial returned benefit must be subtracted

from the fair market value of the donation.

This approach differs from that of the Tax Court in

Scharf v. Comm’r of Internal Revenue, T.C.M. 1973-265, an

earlier case that allowed a charitable deduction for prop-

erty donated to a fire department to be burned. In Scharf,

a building had been partially burned and was about to

be condemned. The owner donated the building to the

No. 11-2078 7

fire department so it could burn it down the rest of

the way. The Tax Court compared the value of the

benefit obtained by the donor (land cleared of a ruined

building) to the value of the public benefit in the form

of training for the firefighters, and found that the

public benefit substantially exceeded the private return

benefit. Thus, the donation was deemed allowable as a

legitimate charitable deduction, and the court proceeded

to value the donation using the established insurance

loss figure for the building. The Scharf court did not

actually calculate a dollar value for the public benefit,

and if it had tried, it probably would have found the

task exceedingly difficult. Although Scharf supports the

taxpayers’ claimed deduction here, its focus on public

benefit measured against the benefit realized by the

donor is not consistent with the Supreme Court’s later

reasoning in American Bar Endowment. The Supreme

Court did not rely on amorphous concepts of public

benefit at all, but focused instead on the fair market

value of the donated property relative to the fair

market value of the benefit returned to the donor. 477 U.S.

at 116-18. The Tax Court ruled correctly in this case that

the Scharf test “has no vitality” after American Bar Endow-

ment. 135 T.C at 487.

With this background, the decisive legal principle for

the Tax Court and for us is the common-sense require-

ment that the fair market valuation of donated property

must take into account conditions on the donation

that affect the market value of the donated property.

This has long been the law. See Cooley v. Comm’r of Internal

Revenue, 33 T.C. 223, 225 (1959) (“property otherwise

8 No. 11-2078

intrinsically more valuable which is encumbered by

some restriction or condition limiting its marketability

must be valued in light of such limitation”). In Cooley,

the donor could not use the retail price of donated cars

as their fair market value because a contractual condi-

tion prevented them from ever being sold at retail in the

United States. The cars had been bought wholesale at a

special discount price on the condition that they be do-

nated overseas. Id. See also Van Zelst v. Comm’r of Internal

Revenue, T.C.M. 1995-396 (requiring consideration of an

injunction against mining in determining value of

donated land); Thornton v. Comm’r of Internal Revenue,

T.C.M. 1988-479 (accounting for cost of moving and re-

interring remains when donating a cemetery for other

uses); Deukmejian v. Comm’r of Internal Revenue, T.C.M.

1981-24 (refusing to value property in fee simple where

the donation contained a condition, requested by the

donee city, that the property be put only to public use).

II. Valuation Methods

As this case demonstrates, however, knowing that one

must account for a condition in a valuation opens up a

second tier of questions about exactly how to do so. The

Tax Court weighed conflicting evidence on valuation

and rejected the taxpayers’ evidence claiming that the

donated house had a value of $76,000. The Tax Court

found instead that the condition requiring destruc-

tion of the house meant that the donated property

had essentially no value. 135 T.C. at 494. The Tax Court

did not err.

No. 11-2078 9

In this case there is no evidence of an actual market

for, and thus no real or hypothetical willing buyers of,

doomed houses as firefighter training sites. Fire depart-

ments typically conduct their training in burn towers,

which are designed to withstand repeated exercises so

that fire departments pay only a rental fee for use of a

tower. Apparently the Village of Chenequa fire depart-

ment has sometimes used a burn tower at a nearby techni-

cal college for training purposes, but there is no record

evidence of how much the department pays for that

use. Sometimes fire departments also conduct exercises

using donated or abandoned property, but there is also

no record evidence of any fire departments paying for

such property. Without comparators from any estab-

lished markets, the parties presented competing experts

who advocated different valuation methods. The tax-

payers relied on the conventional real estate market, as

if they had given the fire department fee ownership of

the house. The IRS relied on the salvage market and

the market for relocated houses, attempting to account

for the conditions proposed in the gift.

The taxpayers’ expert witness is a residential appraiser.

His suggested valuation methods treated the donation

as one of real estate. This was not an ordinary real estate

transaction, however, and the appraiser needed to ac-

count for the fact that only the house was being donated,

while all rights to the three acres on which it sat were

being retained. (The donation necessarily granted a

temporary easement to permit the fire department to

come onto the property to conduct its exercises, but

neither party deemed this of significant value.) The

10 No. 11-2078

taxpayers argued that the “before-and-after” method

should be applied. Their appraiser started with an esti-

mated value of $675,000 for the land and house to-

gether, based on comparisons to recent sales of similar

properties in the area. Using the same method, he esti-

mated a value of $599,000 for the land alone, without

any house on it. He subtracted the latter from the former

to estimate $76,000 as the value of the house alone.

The before-and-after approach is used most often to

value conservation easements, where it is hard to put

a value on the donated conservation use. Experts can

estimate both the value of land without the encumbrance

and the value of the land if sold with the specified use

limitations, using the difference to estimate the value of

the limitations imposed by the donor. As we explain

below, there are significant differences between the

Rolfs’ donation and a conservation easement. While

this approach might superficially seem like a reasonable

way to back into an answer for the house’s value

apart from the underlying land, the before-and-after

method cannot properly account for the conditions

placed on the recipient with a gift of this type. The Tax

Court properly rejected use of the before-and-after

method for valuing a donation of property on the condi-

tion that the property be destroyed.

The IRS presented two experts, both of whom used

a “comparable sales” method of valuation. The IRS as-

serted that a comparable market could be sales of

houses, perhaps historically or architecturally important

structures, where the buyer intends to have the house

No. 11-2078 11

moved to her own land. Witness Robert George is a

professional house mover who has experience through-

out Wisconsin lifting houses from their foundations

and transporting them to new locations. He concluded

that it would cost at least $100,000 to move the Rolfs’

house off of their property. Even more important, he

opined that no one would have paid the owners more

than nominal consideration to have moved this house.

In his expert opinion, the land in the surrounding area

was too valuable to warrant moving such a modest

house to a lot in the neighborhood. George also opined

that the salvage value of the component materials of the

house was minimal and would be offset by the labor

cost of hauling them away. These conclusions were sup-

ported by witness Marcia Solko, who works for the Wis-

consin Department of Transportation and is responsible

for clearing or moving houses off of property purchased

by the state for highway construction. Solko also con-

cluded that the cost of moving the Rolfs’ house off the

property would make it very unlikely that anyone

would pay money to have it moved. Based on this testi-

mony, the IRS argued that since the house would have

had negligible value if sold under the condition that it

be separated from the land and moved away, the house

must also have negligible value if sold under the condi-

tion that it be burned down.

The Tax Court found that the parties to the donation

understood that the house must be promptly burned

down, and the court credited testimony by the fire chief

that he knew the house could be put to no other use by

the department. The court rejected the taxpayers’ before-

12 No. 11-2078

and-after method as an inaccurate measure of the value

of the house “as donated” to the department. The tax-

payers’ method measured the value of a house that re-

mained a house, on the land, and available for

residential use. The conditions of the donation, however,

required that the house be severed from the land and

destroyed. The Tax Court, accepting the testimony of the

IRS experts, concluded that a house severed from the

land had no substantial value, either for moving off-site

or for salvage. Moving and salvage were analogous

situations that the court found to be reasonable approxi-

mations of the actual scenario. We agree with these con-

clusions, which follow the Cooley principle by taking

into account the economic effect of the main condition

that the taxpayers put on their donation. The Tax

Court correctly required, as a matter of law, that the

valuation must incorporate any reduction in market

value resulting from a restriction on the gift. We review

the Tax Court’s findings of fact for clear error and its

conclusions of law de novo. Freda v. Comm’r of Internal

Revenue, 656 F.3d 570, 573 (7th Cir. 2011). We find no

clear error in the factual findings and conclude further

that it would have been an error of law to ascribe

any weight to the taxpayers’ before-and-after valuation

evidence.

The taxpayers argue on appeal that the before-and-

after method actually does take the relevant conditions

into account. Their argument boils down to an assertion

that the “after” value takes the destruction require-

ment into account because the “after” value appraises

No. 11-2078 13

the land after the house was destroyed. This argument

begs the question in classic fashion. No one disputes

that $76,000 worth of home value was lost in the fire.

The disagreement concerns the portion of that value, if

any, that was actually transferred to the fire department

by gift. By deciding to destroy the house and then

making that demolition a condition of their gift, the

taxpayers themselves became responsible for that

decrease in value, even if the fire department provided

the mechanism to accomplish it. None of the value of

the house, as a house, was actually given away.2

The gift was not a timeshare interest, for which a pro-

rated before-and-after valuation might be appropriate,

nor was it a gift to a charity providing housing for

needy families. The taxpayers here gave away only the

right to come onto their property and demolish their

2

We ascribe no sinister motives to the Rolfs in seeking this

deduction, who could reasonably rely on Scharf to conclude

that their proposed valuation might be allowed. A brief look at

Google uncovers news stories about similar donations and

attempted deductions by an ESPN commentator, a former

Oregon gubernatorial candidate, and a New York investment

banker. It would seem that an application of the before-and-after

method to the New York donation might have produced

a valuation of up to $1.2 million dollars. See Sarah

Jordan, They spent $4.2M on this house . . . then let firefighters

burn it down, N.Y. Post, Apr. 18, 2010, available at http://

w w w . n y p o s t . c o m / p / n ew s /lo ca l/th ey _ s p e n t _ d o w n _ t h i s _

house_then_ z4BQw7JNQgNmf0e12ev3VL (last visited Feb. 3,

2012).

14 No. 11-2078

house, a service for which they otherwise would have

paid a substantial sum. (Testimony indicated that the

taxpayers actually paid $1,000 of the department’s costs

as part of their donation.) The demolition condition

placed on the donation of the house reduced the fair

market value of the house to a negligible amount, well

enough approximated by its negligible salvage value.

The authorities the taxpayers cite to support the before-

and-after valuation method relate to conservation ease-

ments and other restrictive covenants, but the features

of this donation are quite different from such an ease-

ment. When an easement is granted, part of the land-

owners’ rights are carved out and transferred to the

recipient. For example, the Forest Service might be

given the right to manage undeveloped land, or a conser-

vation trust might be given the right to control disposi-

tion of property. Because it can be difficult to measure

the value of this sort of right in isolation, experts

instead estimate the difference in sale price for property

with and without similar encumbrances. Here, in

contrast, the initial value of the home can be estimated

with the before-and-after method, but the donation

destroyed that residential value rather than transferred it.

That’s why conservation easements provide a poor

model for the situation here, and other possible valua-

tion models suffer from a lack of supporting evidence.

The value of the training exercises to the fire depart-

ment is not in evidence. The fire chief testified in the

Tax Court that he could not assign a specific value to

the significant public benefit of the training — but in any

No. 11-2078 15

event, we know from American Bar Endowment that

trying to measure the benefit to the charity is not the

appropriate approach. Perhaps the best “comparable

sales” comparison might have been the price paid by

the fire department to rent a burn tower for the length

of time the department conducted exercises in and

around the lake house, but there is no such evidence here.

The Tax Court also undertook a fair market valuation

of the benefit received by the taxpayers. The expert wit-

nesses for the IRS both agreed with Mr. Rolfs’ own testi-

mony (based on his investigation) that the house

would cost upwards of $10,000 to demolish. Rolfs

claimed that he actually received no real value from the

burn because, even after the training exercises were

complete, he still had to pay $10,000 to $15,000 for debris

clearing and foundation removal. The Tax Court did not

credit this latter testimony, finding no substantiation for

this claim in the documentary evidence, which did not

break out construction expenses by type or purpose.

Common sense tells us that whatever destruction was

caused by the fire would have cost money if performed

by workers with sledgehammers or a wrecking ball,

even if additional clean-up was required. We see no

error in the Tax Court’s factual determination, based on

the available evidence and testimony, that the Rolfs

received a benefit worth at least $10,000.

When property is donated to a charity on the condition

that it be destroyed, that condition must be taken into

account when valuing the gift. In light of that condition,

the value of the gift did not exceed the fair market value

16 No. 11-2078

of the benefit that the donating taxpayers received in

return. Accordingly, the judgment of the Tax Court

is A FFIRMED.3

3

The IRS offered an alternate theory for denying the Rolfs’

deduction: that the gift transferred only a limited right to use

(i.e., burn down) a house and therefore was not a qualifying

contribution under 26 U.S.C. § 170(f)(3), which denies deduc-

tions for gifts of most partial interests in property. Under

section 170(f)(3), donations for mere use do not qualify for

deduction if the donor retains a substantial interest that may

interfere with the donated use. See Stark v. Comm’r of Internal

Revenue, 86 T.C. 243, 252-53 (1986). The Tax Court did not reach

this question, and we affirm without reaching it.

2-8-12